Volcker's "Rule" for Preventing Moral Hazard

Former Federal Reserve chairman Paul Volcker is one of few economists with both President Obama’s ear and some sense of the long term consequences of Fed interest rate manipulation. When the dollar was headed for crisis in the 70s, he stood firm to raise rates to 18 percent which, for a time, helped the dollar maintain value. In a recent op-ed piece, he further explains the consequences he sees of bank bailouts.  

From The New York Times:

“A large concern is the residue of moral hazard from the extensive and successful efforts of central banks and governments to rescue large failing and potentially failing financial institutions.

“The long-established “safety net” undergirding the stability of commercial banks — deposit insurance and lender of last resort facilities — has been both reinforced and extended in a series of ad hoc decisions to support investment banks, mortgage providers and the world’s largest insurance company.

“In the process, managements, creditors and to some extent stockholders of these non-banks have been protected.”

Unfortunately, the essay shows the telltale signs of horse trading. Volcker seems to be gaining influence with the administration, between the new “Volcker rule,” to restrict risky trading by commercial banks, and his more frequent meetings with Bernanke at the Fed. However, he also seems to increasingly agree with the Fed’s power to safeguard the system, tip-toeing around what approaches he deems “feasible in today’s world”.

It’s a vague article, and perhaps time may tell whether or not Volcker’s opinion is being redefined to better suit his colleagues, and perhaps it won’t. Either way, you can read Volcker’s complete opinion on how to reform our financial system at The New York Times.

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